Are you interested in getting into rental property investing? It’s an excellent and exciting industry to get into that will challenge your critical thinking skills, your financial skills, your organization, and more.
Before you dive into investing in your first property, you’ll need to get your rental property calculator out — but you need to know all the variables first. Understanding what these are, and how they all work together to determine if the property is worth investing in, is crucial to your investment portfolio.
It’s important to note at this point that these calculations are simplified for understanding and brevity. Use them as a starting point.
In order to get truly accurate estimates and metrics, you’ll need a detailed understanding of the potential property, the expenses, the real estate market, the location, the age of the property, the revenue streams, the cash flow…the list goes on.
These metrics are meant to help you get a greater understanding of your potential investment — not to be used on their own.
Let’s get started.
Net Operating Income (NOI)
Net Operating Income (NOI) is a calculation that’s used to analyze how profitable a real estate investment, in this case a rental property, is.
This is how you calculate NOI:
NOI = Property Revenue − Operating Expenses
NOI uses amounts and earnings pre-taxes.
So, in short, NOI lets you know how profitable a certain property is before taxes and operating expenses come into the picture.
Remember to include all revenue from the property. For rental properties, this includes any rent, earnings from parking spaces or structures, laundry facilities, public amenities, vending machines, and more.
Operating expenses can vary widely depending on the property type, location, age, and more. A few examples include repairs for a distressed property, costs of maintenance, legal fees, salaries for repair workers, landlords, etc.
Besides giving you an idea of the profitability of the property, NOI is also a key figure used for calculating the Capitalization Rate of a property. Speaking of which…
Capitalization Rate
The Capitalization Rate, also called a Cap Rate, is defined as is the ratio of the property’s NOI to the property’s current market value (aka the price). As an equation for a rental property calculator, it looks like this:
Cap rate = Net Operating Income ÷ Price
Many real estate investors and cash home buyers use the cap rate calculation in order to quickly compare various rental property options before an investment. In general, the higher the cap rate is, the better the news for you as an investor.
While not the final say, calculating the cap rate for a property is a great first step to understanding the potential value of a property as a rental investment.
Cash Flow Return on Investment (CFROI)
Cash Flow Return on Investment, also called a Cash On Cash Return, is a metric that helps investors understand the economic return a property or investment will have.
The equation looks somewhat similar to the one for cap rate:
CFROI = Cash Flow ÷ Price
This helps you understand the property’s cash flow and how this will affect your own returns, essentially indicating how well the investment will perform or has performed.
This calculation can also help you understand how the property performs over time. Usually, with steady mortgage rates and increasing revenues thanks to rent & other revenue streams, the ROI on rental properties tends to increase over time.
In general, just like with cap rate, a higher CFROI is better.
Internal Rate of Return (IRR)
Similar to a few other metrics on this list, Internal Rate of Return (IRR) is used to estimate the potential profitability of rental properties for the investor. The IRR looks at the annual total return, “calculating the annual rate earned on each dollar invested for the period it is invested.”
IRR’s calculation is a bit more involved and complicated than the others on this list and can be found here.
Generally, the higher the IRR, the more desirable the investment becomes. Many rental property calculators consider the IRR the most important metric when considering investing in a property.
It has heightened importance in many people’s minds since it takes into account how things change over time and requires more information to calculate, making it a bit more accurate and telling than other more basic calculations.
Use a Rental Property Calculator Before Every Investment
If you need more help understanding these calculations, understanding the rental property calculator value you calculated, or more information about investing in rental property, Growing Edge Properties can help.
We have years of experience helping everyone from buyers to sellers to investors reach their real estate goals. Contact us today to get started or to ask any questions.